PLR 201114009: IRS restores S corporation status after an inadvertent ineligible-shareholder transfer

Plain-English summary

The IRS treated a corporation as continuing to be an S corporation after its shares were transferred to an individual retirement account that was an ineligible shareholder. The transfer would ordinarily have terminated the corporation's S election, but the IRS found the termination inadvertent under IRC § 1362(f). The corporation and its shareholders had continued to treat it as an S corporation and agreed to make required tax adjustments. The IRS also treated the subsidiary as a qualified subchapter S subsidiary from the same date, subject to the validity of the underlying elections and the ruling's conditions.

Ruling snapshot

• Question: Could the corporation retain S corporation treatment after an inadvertent transfer to an ineligible shareholder?
• Outcome: Approved, inadvertent termination relief granted.
• Key authorities: IRC §§ 1361, 1362, and 6110.

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201114009
Third Party Communication: None
Release Date: 4/8/2011
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
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--------------------------------------------- Telephone Number:
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Refer Reply To:
CC:PSI:B02
PLR-132499-10
Date:
December 21, 2010

X = -----------------------------------------------------------------------------------------------
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Subsidiary = -----------------------------------------------------------------------------------------------
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A = -----------------------------------------------------------------------------------------------
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IRA = -----------------------------------------------------------------------------------------------
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Date 1 = --------------------------

Date 2 = ----------------------

Date 3 = -----------------------

Date 4 = ------------------

State = --------
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Year = -------

Dear -------------

This letter responds to a letter dated July 23, 2010, and subsequent correspondence, submitted on behalf of X by its authorized representative, requesting relief under
§ 1362(f) of the Internal Revenue Code.
PLR-132499-10
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The information submitted states that X was incorporated under the laws of State on Date 1 and elected to be treated as an S corporation, effective Date 2. In addition, X elected to treat Subsidiary as a qualified subchapter S subsidiary (“QSub”), effective Date 2. On Date 3, X issued shares of X to an individual retirement account (IRA), an ineligible shareholder, for the benefit of A, thereby terminating X’s S election on Date 3. Both A and X were unaware that the transfer caused a termination. X and all its shareholders continued to treat X as an S corporation. In early Year, X’s accountant informed X that the IRA was an ineligible shareholder of X. On Date 4, the IRA distributed its shares in X to A.

X represents that the circumstances resulting in the termination of X’s S corporation election were inadvertent and were not motivated by tax avoidance or retroactive tax planning. X and its shareholders have agreed to make such adjustments (consistent with the treatment of X as an S corporation) as may be required by the Secretary.

Section 1362(a) provides that, except as provided in § 1362(g), a small business corporation may elect, in accordance with the provisions of § 1362, to be an S corporation.

Section 1361(a)(1) defines an “S corporation” as a small business corporation for which an election under § 1362(a) is in effect for the taxable year.

Section 1361(b)(1)(B) provides that a “small business corporation” means a domestic corporation that is not an ineligible corporation and that does not have as a shareholder a person (other than an estate, a trust described in §1361(c)(2), or an organization described in § 1361(c)(6)) who is not an individual.

Section 1362(d)(2)(A) provides that an election under § 1362(a) shall be terminated whenever (at any time on or after the first day of the first taxable year for which a corporation is an S corporation) such corporation ceases to be a small business corporation. Section 1362(d)(2)(B) provides that the termination shall be effective on and after the date of cessation.

Section 1361(b)(3)(B) defines a QSub as a domestic corporation that is not an ineligible corporation, if 100 percent of the stock of the corporation is owned by an S corporation, and the S corporation elects to treat the corporation as a QSub.

Section 1362(f) provides that if (1) an election under § 1362(a) by any corporation was terminated under § 1362(d)(2) or (3), (2) the Secretary determines that the circumstances resulting in such termination were inadvertent, (3) no later than a reasonable period of time after discovery of the event resulting in the ineffectiveness, steps were taken (A) so that the corporation is a small business corporation, or (B) to acquire the required shareholder consents, and (4) the corporation, and each person who was a shareholder of the corporation at any time during the period specified
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pursuant to § 1362(f), agrees to make such adjustments (consistent with the treatment of the corporation as an S corporation) as may be required by the Secretary with respect to such period, then, notwithstanding the circumstances resulting in such ineffectiveness, the corporation shall be treated as an S corporation during the period specified by the Secretary.

Based solely on the information submitted and the representations made, we conclude that X’s S corporation election terminated on Date 3, under § 1362(d)(2), because of the transfer of shares of X to an ineligible shareholder, and that this termination of X’s S election was an inadvertent termination within the meaning of § 1362(f). Accordingly, pursuant to the provisions of § 1362(f), X will be treated as an S corporation from Date 3 and thereafter, provided X’s S corporation election was valid and was not otherwise terminated under § 1362(d). Furthermore, Subsidiary will be treated as a QSub of X as of Date 3 and thereafter, provided that Subsidiary’s QSub election is otherwise valid.

As a condition for this ruling, for the tax periods beginning on or after Date 3, A will be treated as the shareholder of the shares of stock held by the IRA. All of X’s shareholders in determining their respective income tax liabilities during the termination period and thereafter, must include their pro rata share of the separately stated items of income (including tax-exempt income), loss, deduction, or credit and non-separately stated computed items of income or loss of X as provided in § 1366, make any adjustments to basis provided in § 1367, and take into account any distributions made by X as provided in § 1368. If X or its shareholders fail to treat X as described above, this ruling will be null and void.

Except as specifically ruled above, we express no opinion concerning the federal tax consequences of the transactions described above under any other provision of the Code. Specifically, no opinion is expressed on whether X is otherwise eligible to be treated as an S corporation or whether Subsidiary is otherwise eligible to be treated as a QSub.

This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.
PLR-132499-10
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Pursuant to a power of attorney on file with this office, a copy of this letter is being forwarded to X’s authorized representative.

Sincerely,

Charlotte Chyr
Senior Technician Reviewer, Branch 2
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

Enclosures (2)
Copy of this letter
Copy for § 6110 purposes

cc: